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The Greek debt crisis refuses to go away

Thursday, August 19, 2010

By Paul Martin

The European Commission has approved the next €9bn (£7.4bn) tranche of loans for Greece but the underlying economy continues to deteriorate as Greek banks suffer a record loss of deposits and output contracts at a quickening pace.

A report by HSBC said banks had lost 8pc of their entire deposit base in the five months to May. “The Greek market has never, since the first data in 2001, experienced such attrition,” said banking analyst Joanna Telioudi.

While some withdrawals point to capital flight by wealthy Greeks, it is clear that households and companies are running down savings to make ends meet. The Athens Chamber of Commerce warned yesterday that its members are in “dire straits”, with a majority facing a liquidity threat.

Simon Ward from Henderson Global Investors said Greek lenders are covering their funding gap through loans from the European Central Bank (ECB), which reached a record €96bn in July. “The question is how much eligible collateral they have left to take to the ECB. It must be nearing the limits,” he said.

“What is worrying is that this is not just Greeks. Portuguese banks borrowed €50bn in July compared to €41.5bn in June. Together with Ireland and Spain they have borrowed €387bn from the ECB,” he said.

Oli Rehn, the EU economics commissioner, said Greece has achieved “impressive budgetary consolidation and swift progress with major structural reforms” , meeting the terms for a second loan under the €110bn rescue plan with the International Monetary Fund.

Mr Rehn said “risks remain”, warning that tax revenue was falling far short of the 16pc rise targeted for the year. There was slippage by local governments and social security funds.

The green light from Brussels failed to offer any respite for Greek bonds. Spreads on 10-year Greek debt rose to 835 basis points over German debt. They are trading once again at the crisis levels of early May, before the EU launched its “shock and awe” rescue and the ECB began purchasing Greek bonds.

Stephen Lewis, of Monument Securities, said investors doubt whether the EU/IMF plan is workable without debt restructuring and devaluation, the usual IMF cure for countries with such problems. IMF documents show that Greece’s public debt will rise to 150pc of GDP after three years, even if the government complies fully.

“The markets suspect that Greece will have to restructure its debt sooner or later, and bondholders will be the losers. They don’t believe that Greece’s euro membership on present terms is economically viable. The country doesn’t have the freedom it needs to get out of this crisis,” he said.

Ian Stannard, a currency strategist at BNP Paribas, said investors have been unsettled by news that Spain is planning to soften its austerity package by renewing €500bn of rail and road projects. “The fear is that if Spain backtracks, then others like Greece are going to follow. This is creeping on to the radar screen,” he said.

Mr Stannard said a report on Greece by Spiegel magazine entitled “Entering a Death Spiral” revived worries about political stability, painting a picture of a country nearing popular revolt. It said unemployment had reached 60pc to 70pc in depressed areas.

“The entire country is in the grip of a depression,” said Speigel. “Everything seems to be going downhill. The spiral is continuing unabated and there is no clear way out.”

The Greek economy shrank by 1.5pc in the second quarter, not helped by transport strikes that caused tourism revenues to fall 16pc in June. The risk is that country finds itself chasing its tail, trying to sustain a rising stock of debt on a diminishing base. Critics suspect that Greece has already passed the point of no return for debt dynamics, and some IMF officials privately agree.

Chris Pryce, of Fitch Ratings, said Greece is teetering on the edge of junk status but can still claw its way back. He expects the economy to contract by 4.5pc to 5pc this year, worse that official forecasts. This is manageable. The key is whether the pace of decline slows enough next year to make q dent in the deficit, and whether the country will accept yet another round of austerity.

“Everybody is away on holiday. When they get back they will have to face their miserable new world going into the autumn, and then we will see,” he said.